EUR 850.00 For Business Accounts Only

Morningstar | Newcrest’s Acquisition of Red Chris Provides Long-Term Options; FVE Maintained

Scepticism is warranted when it comes to the mining industry and acquisitions as meaningful capital has at times been destroyed, particularly through the recent China boom. However, we’re reasonably comfortable with Newcrest’s proposed acquisition of 70% of the Red Chris mine. The company will pay USD 807 million to Canadian listed Imperial Metals for the interest. Importantly, Newcrest will be the operator and the interest well be held directly at the mine level. Imperial Metals is financially weak and appears a motivated seller.

The deal looks opportunistic and comes with a relatively long list of positives. A financially destressed seller, a massive mineral endowment, a long runway for potential operational improvements and possible long-term exploration upside. Similarities in the resource to Cadia East means planned improvements play to Newcrest’s strengths. They include potential for a large scale, low cost, underground mine, use of ore sorting to improve the grades processed and adoption of new processing plant technologies to more efficiently recover the valuable metals. Newcrest is the only global gold major with expertise in block caving. That in itself is replicable over time but likely narrowed the field of buyers.

For now, we value the acquisition at cost and maintain our AUD 23 per share fair value estimate for Newcrest. Increases in the gold and copper prices see Newcrest’s shares trade at a modest premium to our fair value estimate. However, we’re still positive about the outlook for the firm. We see further incremental efficiency gains at Lihir and Cadia. New technology should improve the cost position and outlook for Telfer. The mineral endowment that comes with Red Chris is massive and potentially gives Newcrest another mine from which to implement new technologies and extract incremental gains. The seller was motivated, but the deal comes when the industry is cashed up and assets aren’t cheap.

The existing mine and processing plant gives Newcrest a base from which to make incremental improvements. Longer-term work will focus on maximising value with bulk underground mining. The resource is analogous to Cadia East, hosting 20 million ounces of gold and 5.9 million tonnes of copper at very similar grades. Cadia East is larger though, containing 35 million ounces of gold and 7.7 million tonnes of copper. There’s potential to add value by identifying higher grade portions of the orebody to mine first. This is important to underpin the initial capital spend for a large-scale underground mine and to get a fast capital payback.

Key negatives are the acquisition takes place when the cycle is good and competitors are cashed up. This tends to mean the price paid for acquisitions is pretty full. Grades are relatively low, and the existing 11 million tons a year mine is marginal. Newcrest management is also yet to release its plans on how much it expects to spend on capital to improve the mine, what kind of production rates it's targeting, and what the operating costs are likely to be. So, the market is likely relying on bulk underground mine analogies, resource multiples and trust of management to value the deal. Key cost and production estimates won’t come out until the transaction has closed, likely in August. Detailed financials on the future underground plans are likely be longer dated, requiring additional exploration and studies to firm up.

The acquisition of 70% of Red Chris looks likely to go ahead. The seller, Imperial Metals, is under severe financial stress. Imperial Metals’ net debt at the end of September was CAD 970 million. Net operating cash flow was negative CAD 10 million for the first nine months of 2018. Free cash flow, net of asset sales, was negative CAD 57 million. The proceeds from Newcrest’s purchase will allow Imperial Metals to be debt free. Newcrest’s balance sheet will remain solid post the acquisition. On our base case, we expect net debt/EBITDA to remain well below 1.0 for the five-year forecast period and to move below 0.5 from 2021 onward. EBIT/net interest is comfortable for our base case, remaining above 6.0 for our forecast period.